Fixed interest is supposed to be safe. Yet many a debenture investor has sweaty palms right now. Nervous private investors have been contacting their financial planners worried about the safety of their debenture investments.
The reality is that the majority of finance companies in New Zealand will come out the
other side of the present squeeze intact. But those looking for alternative fixed interest investments might take a look at listed debt securities - or for that matter high interest bank accounts and term deposits.
While investors are big on debentures, many know little about debt securities - a fixed interest investment which trades on the NZDX - a subsidiary of the NZX.
Debt securities are, in effect, loans to companies. Telecom has recently issued a fixed rate bond on the NZDX, says David Speight, director of fixed interest at Direct Broking. On the day of issue a security, such as Telecom's bond, has a "face value", which will be the amount it pays back on maturity (providing the company hasn't gone bust).
The Telecom bond pays a fixed interest rate - or coupon - of 6.92 per cent. That rate remains the same throughout the life of the investment. However, if interest rates go up by 1 per cent, then the price you pay for a second-hand bond on the NZDX is likely to go down because the coupon rate is lower than newly issued securities, so you may buy that security at a discount to face value - in this case about 1 per cent multiplied by the number of years it has to run, giving you a higher yield than the coupon figure.
The interest rate will be determined by several factors including the credit rating of the company or organisation issuing the debt security. If like Telecom the company has an investment grade rating from Standard & Poor's, it is likely to offer a lower interest rate than a company with a lower grade rating.
Even if the price drops, you can choose to hold your security until maturity, in which case all of the principal will be repaid.
Unlike finance company debentures, the debt securities market is a pure market with "pricing determined by the market, not the product provider", says David Yates, financial planner at Integrate Financial Services in Takapuna. "Whereas with debentures - the provider determines what rate they are willing to pay to lenders."
What's more, you'll be investing in some of the country's best known names such as Whitcoulls, Fletcher Building, Fonterra, Sky City Entertainment, Vector or Tower Finance.
Bonds are generally more stable than equities - unlikely to swing more than 5 per cent in either direction in normal circumstances, says Speight.
If a company fails, debt security holders are ahead of shareholders in the queue for any payout. But they are not an alternative to shares but rather a part of a balanced portfolio that will help you weather the ups and downs of the share and property markets. There will always be savvy investors who are able to make a buck on the rises and falls in the market, by predicting where interest rates are going. But Steven Anderson, head of Cannex New Zealand, says the private bond trader is a rare breed and would have to be market watching day in and day out to have a chance at beating the experts. "The average punter ain't got a hope," he says. Consequently, private investors should look at debt securities as a way to invest in fixed interest.
Yates says the liquidity of the market is the beauty of debt securities - you can sell them at any point - unlike debentures, which you're usually stuck with until maturity. He says it also means that the price better reflects the risk. Debenture rates are set by the company issuing them.
That's not to say that markets can't get it wrong, says John Rowley head of Macquarie Financial Services Group in New Zealand. Feltex was a classic example of that - albeit on the NZX, not NZDX. And a company with a strong credit rating could go to the wall thanks to fraud or other unexpected occurrence.
ABN Amro Craigs' head of fixed interest, Deidre Copley, says her company prefers listed debt securities over debentures on several grounds including the ability to better monitor clients' portfolios and the ability to sell on should clients' risk profiles change.
"With [debt] securities many of them are credit rated with Standard & Poor's or they are listed companies and we have access to financial analysts' reports on the companies as well as visiting them ourselves."
The company's client portfolios include debt securities traded on the NZDX, and others that are not listed, but still traded such as ASB, Transpower or the Housing Corporation. Some clients also have exposure to overseas securities.
And this is an important point. Like most financial markets here, the NZDX is relatively small and said to be under-utilised. There is nothing stopping investors buying similar securities overseas in larger markets.
You can, if you choose, also invest in managed funds, which invest in debt securities. The ING Secure Income Fund invests primarily in a variety of New Zealand fixed interest securities and ING's Regular Income Fund invests internationally. But says Geoff Brown, products group manager at NZX, if you choose to invest in a fund, you will need to pay a management fee, which reduces the yield on your investment.
Most debt securities are paying between 7.5 per cent and 8.5 per cent yield at the moment, says Brown. You won't get that much less for putting your money in an online save type account such as Superbank's SuperAccess account now paying 7.30 per cent.
The downside of high interest online bank accounts is that the interest rates can change. However, many banks provide attractive rates for term deposits. At RabobankPlus, which has the highest Standard & Poor's credit rating of any bank in New Zealand, you can get a six months' fixed interest investment paying 7.5 per cent or five years for 6.95 per cent.
The book, Understanding Fixed Interest Rates published by Macquarie Financial Services, is available free from the Good Returns Bookshop. Visit www.goodreturns.co.nz/books.
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Fixed interest is supposed to be safe. Yet many a debenture investor has sweaty palms right now. Nervous private investors have been contacting their financial planners worried about the safety of their debenture investments.
The reality is that the majority of finance companies in New Zealand will come out the
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